The truth about negative gearing
April 30, 2019 - Blog
I’m not sure there is a hotter topic in the property space than negative gearing at the moment.
That’s because it could be one of the biggest issues that decides the upcoming Federal Election.
Now, this blog is not a political one.
I’m not here to tell you which party you should vote for, however, as an experienced property advisor I believe I need to explain what negative gearing is and what it isn’t.
You see, there is a lot of misinformation out there about negative gearing, including a false belief that most investors buy property so they can solely reduce their tax.
This is incorrect – if anybody buys property just to minimise tax, they want their head read (despite what Kerry Packer said back in 1991!)
The reality is that negative gearing is not an investment strategy, it is a tax outcome.
Plus, negative gearing applies to any income-producing asset, including shares, and has been a legal taxation deduction in Australia for nearly 100 years.
At the end of the day, gearing is simply the practice of borrowing money to purchase an income-producing asset.
Positive gearing occurs when income is greater than expenses (including interest costs) before tax.
Negative gearing occurs when income is less than expenses (including interest costs) before tax.
Negative gearing is a moment in time
Negative gearing is also a mere taxation moment in time.
What I mean by that is that most investors will become positively geared over time because their rental income should increase while generally their interest costs will decrease during their investment ownership.
In fact, according to the 2018 PIPA Investor Sentiment Survey, about 60 per cent of investors indicated they would be positively geared within five years.
When that happens, they will be making a profit, which ultimately means they will pay more – and not less – tax every year.
Negative gearing is more prevalent at the start of an investor’s journey because they generally have higher loan to value ratios or LVRs.
That means that their mortgage repayments will be higher, and their rental income might not be able to cover all the interest costs at the outset.
Also, there are a number of other expenses involved in holding property such as council rates, management fees, and insurances, which are also legal tax deductions for income-producing assets.
It bugs me that the fact that investors pay billions of dollars in Capital Gains Tax each year when they sell their properties never seems to get much air-time.
In fact, PIPA modelling has found that an investor who bought a $675,000 property today would receive about $23,583 in negative gearing benefits over a decade, but they would pay $104,703 in CGT if they sold the asset – leaving the Federal Government with a $81,118 net gain!
Capital growth is key
While you can’t hold an investment property for the long term without the cash flow to see you through, it is not rental income that will make you wealthy.
All the investment properties that we recommend to our clients are chosen because we believe they have strong capital growth potential.
They are generally located in desirable areas of Sydney such as the Lower North Shore, Eastern Suburbs and the Northern Beaches, which are continually in strong demand from buyers.
As we all know, demand is key to price growth over the medium- to long-term.
Labor’s plan to restrict negative gearing is slated to begin on 1 January next year, however, there are a number of things that need to happen for that to occur.
The first, of course, is that Labor needs to win the election.
The second is that the legislation needs to pass both the House of Representatives and the Senate, which does not appear to be a sure thing at this point in time.
Thirdly, Labor wouldn’t be the first political party in the world to change its mind about a policy once it won office, especially if there are economic headwinds.
One thing that is likely to happen if Labor is victorious on 18 May is that the market could experience an upswing while savvy investors buy existing properties to beat the aforementioned 1 January deadline.
That’s because existing investors of any type of property before that date will be quarantined from the new rules.
So, given established property does have a history of higher capital growth over the long-term, it makes financial sense to get in to the market and invest in quality established properties between now and then.
If you would like to get in to the market this year and find out how you can take advantage of the current conditions, please get in touch with STRAND today and ask about our FREE Property Roadmap Meeting to help identify your next move towards buying a property.